RISK ASSESSMENT

Activity supported by investment

Although lower, growth is expected to remain comfortable in 2018, continuing to be driven by investment. Investment will be supported notably by the continued construction of the 41 km long first section (Podgorica – Mateševo) of the Bar-Boljare motorway project, which will eventually link the Port of Bar to Boljare, on the Serbian border. Foreign investment in tourism infrastructure is set to continue, further developing a sector that already contributes 10% to GDP. However, the construction of a second coal-fired power station in Pljevlja seems to be compromised by tighter European environmental standards. Consumption, both private and public, will contribute little to growth, in connection with the fiscal consolidation. The contribution of foreign trade will be negative due to the increase of imports related to the construction of the motorway.

Consolidation of public and foreign accounts linked to the completion of the motorway construction project

Although diminished, the public deficit will remain high, leading to a further increase in debt (78% of GDP at the end of 2016, 60% of GDP for its foreign portion alone). However, the consolidation of the budget will intensify. Indirect taxation, which already represents 67% of tax revenue, will be further increased. The ordinary VAT rate will thus increase from 19% to 21% in early 2018. Levies on tobacco, sodas, and alcohol will rise. Control will be facilitated by the widespread use of connected cash registers. The exceptional 2% increase of the tax on high incomes (single rate of 9%) is expected to be extended. The action on current expenditure (social benefits and salaries mainly), which is equivalent to 80% of total expenditure, will be smaller. Salaries of senior civil servants will be further cut, while the increase will not exceed 1% for others. Faced with this, the pension deficit borne by the State and mainly due to early retirement represents more than 3% of GDP. The tax cuts designed to attract foreign investments in tourism, such as the application of a reduced VAT rate of 7% for luxury hotels, are costly. However, the critical obstacle is the construction of the motorway, without which the budget would be balanced. The cost of the first segment represents one quarter of GDP. The construction by China Road & Bridge, 30% of which is local subcontracted, is 85% financed by a 20-year loan in dollars from Exim Bank at a rate of 2% with a grace period of six years. The country is responsible for the remaining cost. Construction should be completed in 2019, allowing the balance to become positive and the debt to fall quickly as of 2020. It seems certain that the construction of the remaining 136 km, for an equivalent cost, will not be possible without obtaining concessional funding. Nevertheless, subject to construction of the Serbian portion, this route would improve commercial and tourist trade with Europe through Serbia, as it would replace a dangerous road often closed in winter.

The current account deficit will remain substantial in 2018 due to the abyssal trade deficit in goods (45% of GDP). Exports, mainly metals (aluminium from Kombinat Aluminijuma in Podgorica and steel from the Toscelik steel mill in Nikšić) and electricity, which are very sensitive to international economic conditions and rainfall, are largely offset by imports of equipment for road infrastructure, but also by imports of food and oil products. Tourism generates a surplus representing 20% of GDP. Russians, who constitute one quarter of the summer arrivals, have not been sensitive to the country’s alignment with the Western position on Ukraine or the country’s accession to NATO. In the end, half of the current account deficit is financed by FDI, and the balance is financed by debt and undeclared capital inflows invested in secondary residences. Foreign debt represented 167% of GDP at the end of 2016. Its recent growth is due to the growth in its public share (one third), a consequence of the external financing of the public deficit and the disbursement of the Chinese loan for the motorway.

Frozen political scene

The Democratic Party of Socialists (DPS) - formed from the former Communist party and dominators of the political scene since 1991 - came out on top in the October 2016 legislative elections, winning 36 out of 91 seats. Thanks to the withdrawal of the DPS’s historic leader, Milo Djukanovic, and the parliamentary boycott by the opposition dominated by the Democratic Front (pro-Russian) – which still disputes the results –, Duško Marković, vice-prime minister in the previous government, took the lead of a coalition government uniting the DPS and the minority ethnic parties. The government has completed the NATO accession process and is working to obtain European Union (EU) membership. Corporate life is complicated by corruption, the politicisation of the legal system (harming the performance of contracts and the handling of insolvency), organised crime, an inaccurate land register, and slow administrative procedures. However, EU accession negotiations are leading to improvements in the business climate. In 2016, Montenegro was in 51st place out of 190 in the World Bank’s Doing Business survey and 77th out of 138 in the Global Competitiveness Report.